Inflation Acadmic Overview

7/27/2019 Inflation Acadmic Overview

1/29

INFLATION

1


2/29

Contents

What is inflation: meaning

Theories of inflation: four different theories

Control measures

How is inflation measured Effects of inflation

Examples of inflation

2


3/29

INFLATION

3

Inflation is nothing

more than a sharp

upward rise in price

level.

Too much money

chasing, too few

goods. Inflation is a state in

which the value of

money is falling i.e.

prices are rising.


4/29

Theories of inflation

4

Demand-pull

inflation

Cost-push inflation

Quantity theory of

money

Phillips Curve


5/29

Demand-pull inflation Demand-pull inflation happens where there is 'too much

money chasing too few goods'. Excessive growth indemand literally pulls prices up.

Demand-pull inflation happens when the level of aggregate

demand grows faster than the underlying level of supply. This

may be easier to imagine, if you think of supply as the level ofcapacity. If our capacity to produce is growing at 3%, and the

level of demand grows at the same rate or slower then we don't

have a problem. We can produce all we need. However, if our

capacity grows at 3%, but demand grows faster, then we have a

problem. In effect we have 'too much money chasing too fewgoods', and we can't manage to produce all we need. Something

has to give, and it is prices that are forced up, therefore causing

inflation. We can see all this in the diagram below. As the

aggregate demand curve shifts to the right, the price level rises -

inflation.5


6/29

Demand-pull inflation

6


7/29

Cost-push inflation

If costs rise too fast, companies will need to put prices up tomaintain their margins. This will cause inflation.

Cost-push inflation happens when costs increase independently of

aggregate demand. It is important to look at why costs have increased,

as quite often costs are increasing simply due to the economy booming.When costs increase for this reason it is generally just a symptom of

demand-pull inflation and not cost-push inflation. For example, if wages

are increasing because of a rapid expansion in demand, then they are

simply reacting to market pressures. This is demand-pull inflation

causing cost increases.

However, if wages rise because of greater trade union power

pushing through larger wage claims - this is cost-push

inflation. The aggregate supply curve shifts left because of

the cost increase, therefore pushing prices up.

7


8/29

Cost-push inflation So why might costs get pushed up, causing inflation?

There are a number of possible sources of rising costs.

Wages

If trade unions gain more power, they may be able to push

wages up independently of consumer demand. Firms thenface higher costs and are forced to increase their prices to

pay the higher claims and maintain their profitability.

Profits

If firms gain more power and are able to push up prices

independently of demand to make more profit, then this is

considered to be cost-push inflation. This is most likely

when markets become more concentrated and move

towards monopoly or perhaps oligopoly.8


9/29

Cost-push inflation Exhaustion of natural resources

As resources run out, their price will inevitably gradually rise.

This will increase firms' costs and may push up prices until they

find an alternative source of raw materials (if they can). This has

happened with fish stocks. Over-fishing has put many types of

fish and fish-based products under extreme pressure, forcingtheir price up. In many countries equivalent problems have been

caused by erosion of land when forests have been cleared. The

land quickly becomes useless for agriculture.

Taxes

Changes in indirect taxes (taxes on expenditure) increase the

cost of living and push up the prices of products in the shops. An

example would be when the level of service tax was increased.

9


10/29

Cost-push inflation

Imported inflation

We now work in a very global economy and many

firms import a significant proportion of their raw

materials or semi-finished products. If the cost of

these increases for reasons out of our control, thenonce again firms will be forced to increase prices to

pay the higher raw material costs.

10


11/29

Cost-push inflation

11


12/29

Quantity theory of money excessive money supply growth can also be a cause

of inflation. The quantity theory of money explains

why this happens.

The classical economists view of inflation revolved aroundthis theory, and this theory was in turn derived from the

Fisher Equation of Exchange. This equation says that:

MV = PT

where:

M is the amount of money in circulation

V is the velocity of circulation of that money

P is the average price level, and

T is the number of transactions taking place

12


13/29

Quantity theory of money The equation is in fact an identity/truism. It says that the amount

of the money stock times the rate at which it is used for

transactions will be equal to the number of those transactions

times the price of each transaction. It will always be true, as it

simply says that National Income will be equal to National

Expenditure and basic macroeconomics tells us that this is trueanyway. So nothing stunning there! However, what makes it

important is what classical economists predicted from it.

Classical economists suggested that V would be relatively stable

and T would always tend to full employment. Therefore they

came to the conclusion that: In other words increases in the money supply would lead to

inflation. The message was simple; control the money

supply to control inflation.

13


14/29

Phillips Curve The Phillips Curve is a relationship between unemployment

and inflation discovered by Professor A.W.Phillips. The

relationship was based on observations he made of

unemployment and changes in wage levels from 1861 to 1957.

He found that there appeared to be a trade-off between

unemployment and inflation, so that any attempt by governmentsto reduce unemployment was likely to lead to increased inflation.

The curve sloped down from left to right and seemed to

offer policy makers with a simple choice - you have to

accept inflation or unemployment. You can't lower both. Or,of course, accept a level of inflation and unemployment that

seemed to be acceptable!

14


15/29

Phillips Curve

15


16/29

HOW TO CONTROL INFLATION

1

6

Monetary

Measures

FiscalMeasures

Other

Measures


17/29


18/29

2.Fiscal measures- Measures taken by the government tocontrol inflation.

A: Decrease in public expenditure-One of the mainreasons of inflation is excess public expenditure likebuilding of roads ,bridges etc. Government shoulddrastically scale down its non essential expenditure.

B-Delay in payment of old debts:Payment of old debtsthat fall due should be postponed for sometime sothat people may not acquire extra purchasing power.

C-Increase in taxes :Government should levy some new

direct taxes and raise rates of old taxes.

D-Over valuation of money: To control the over valuationof money it is essential to encourage imports anddiscourage exports


19/29

Other measures

1 Increase in the production-One of the majorcauses of the inflation is the excess of demand over

supply ,so those goods should be produced morewhose prices are likely to rise rapidly .In order toincrease production public sector should beexpanded and private sector should be given moreincentives.

2 Proper commercial policy-Those goods whichare in scarcity should be imported as much aspossible from other countries and their export shouldbe discouraged.

3 Encouragement to savings

During inflationgovernment should come out with attractive savingschemes. It may issue 5 or 10 year bonds in order toattract savings.


20/29

How is it Measured?

2

0

Consumer Price Index

Wholesale Price Index


21/29

Consumer Price Index

2

1

CPI is a measure estimating the average price of

consumer goods and services purchased by

households.

CPI measures a price change for a constant market

basket of goods and services from one period to thenext within the same area (city, region, or nation).

It is a price index determined by measuring the price

of a standard group of goods meant to represent the

typical market basket of a typical urban consumer.The percent change in the CPI is a measure

estimating inflation.


22/29

Wholesale Price Index

2

2

WPI was published in 1902,and was one ofthe economic indicators available to policymakers until it was replaced by most

developed countries by the CPI market.index in the 1970.

WPI is the index that is used to measurethe change in the average price level of

goods traded in wholesale market. Some countries (like India and The

Philippines) use WPI changes as a centralmeasure of inflation.


23/29

Problems with WPI

2

3

In present day service sector plays a key role in Indianeconomy. Consumers are spending loads of money on

services like education and health. And these services

are not incorporated in calculation of WPI.

WPI measures general level of price changes either at

level of wholesaler or at the producer and does not take

into account the retail margins. Therefore we see here that

WPI does give the true picture of inflation.

WPI is supposed to measure impact of prices on

business. But we use it to measure the impact onconsumers. Many commodities not consumed by

consumers get calculated in the index.


24/29


25/29

Inflation rate

2

5

PI for a certain year - PI for a comparative year X 100

PI for a comparative year


26/29

2006-2007 2007-2008

Inflation 7.8 12.0

Food inflation 10.3 17.6

Non-food inflation 6.2 6.8

INFLATION RATES

2

6


27/29

EFFECTS OF INFLATION

2

7

They add inefficiencies in the market, and make itdifficult for companies to budget or plan long-term.

Uncertainty about the future purchasing power of

money discourages investment and saving.

There can also be negative impacts to trade from an

increased instability in currency exchange prices

caused by unpredictable inflation.

Higher income tax rates.

Inflation rate in the economy is higher than rates in

other countries; this will increase imports and reduceexports, leading to a deficit in the balance of trade.


28/29

EXAMPLES OF INFLATION

2

8

Increase in the price of wheat

Increase in the price of oil

Increase in the price of rice

Increase in the price of CNG Increase in the price of sugar

Increase in the fee of MBA

(Weekend) program of IPUniversity!


29/29

Thank you

for listening!

2

9

Pradeep Kumar (MBA-fm) (44)

Inflation Acadmic Overview

Documents

Transcript of Inflation Acadmic Overview